Performance and Valuation Prime™ Chart
First Solar, Inc. (NASDAQ:FSLR) is a leading global provider of comprehensive photovoltaic solar systems, which utilize its advanced module and system technology. In recent years, the firm has seen profitability levels compress as competition has increased and governments have reduced their solar subsidy programs. However, with the Levelized Cost of Electricity (LOCE) of utility-scale solar continuing to decline, solar is beginning to reach levels competitive with other forms of energy generation, such as coal and natural gas. This provides the perfect opportunity for well-positioned firms such as FSLR to begin to capitalize on years of investment and expansion, allowing for material ROA' expansion and equity upside.
Prior to 2013, FSLR saw a pronounced boom and bust cycle in their profitability, with ROA' rising from a low of -43% in 2004 to a peak of 46% in 2009. However, as increased competition and reduced subsidy programs resulted in excess supply, ROA' subsequently declined to just 8% in 2013, where it has stabilized since. During the firm's early years from 2005-2011, Asset' growth was very aggressive, ranging from 54-182%. However, since 2012 Asset' growth has been muted, ranging from -4% to 13% as the firm has attempted to rationalize its balance sheet in an increasingly competitive environment.
For context, the PVP chart below reflects the real, economic performance and valuation measures of First Solar, Inc. after making many major adjustments to the as-reported financials. This chart, along with all of the charts included in this article, as well as the detail behind the graphics, can be found here.
The four panels above explain the company's historical corporate performance and valuation levels plus consensus estimates for forecast years as well as what the market is currently pricing in, in terms of expectations for profitability and growth.
The apostrophe after ROA', Asset', V/A', and V/E' is the symbol for "prime" which means "adjusted." These calculations have been modified with comprehensive adjustments to remove as-reported earnings, asset, liability, and cash flow statement inconsistencies and distortions. To better understand the PVP chart and the following discussion, please refer to our guide here.
Performance Drivers - Sales, Margins and Turns
It can be helpful to break down ROA' into its DuPont formula parts, Adjusted Earnings Margin (Earnings' Margin) and Adjusted Asset Turnover (Asset' Turns), which are the cleaned up margins and turns metrics used to calculate ROA'. The chart below details both Earnings' Margin and Asset' Turns historically, to help us better understand the drivers of the firm's profitability and performance.
The ROA' boom/bust cycle has been driven by both Earnings' Margins and Asset' Turns. While Earnings' Margins climbed from a low of -98% in 2004 to a peak of 36% in 2009, competitive headwinds drove them to just 12% in 2015. Meanwhile, from 2004-2008, Asset' Turns increased from 0.4x to 1.5x, before falling to 0.6x in 2011, and stabilizing at 0.7x levels since.
Embedded Expectations Analysis
As investors, understanding what the market is embedding in the stock price in terms of expectations is paramount to making good decisions. Without understanding what the market is pricing in, it is impossible to claim that the market is wrong. We derive market expectations for the firm from valuations and historical performance trends, to give a clearer picture into what the market is projecting for the firm.
FSLR is currently trading at a 0.5x V/A', which is historically low, and a 50% discount to Asset' values. At these levels, the market is pricing in expectations for ROA' to decline from 8% in 2015 to 2% in 2020, accompanied by 9% Asset' growth.
Analyst and Management Expectations and Alignment
Analysts have expectations in line with the market, projecting ROA' to decline to just 4% by 2017, accompanied by 5% Asset' growth.
However, our qualitative analysis of the firm's Q3 2016 earnings call highlights that management is confident in their ability to meet updated guidance, particularly non-GAAP operating income, net sales, and gross margins, and that TetraSun charges will be less than initially expected. Additionally, they are confident about the sustainability of increased volumes in France given the increasing geographical diversity, and that their O&M business has great opportunities for continued growth. Furthermore, they are confident that they are well positioned to meet opportunities with NextEra and Southern, and that they can walk away from module supply if the economics cease to make sense.
A major benefit of adjusting as-reported financial statements is to clear away accounting distortions, to allow for more accurate peer-to-peer comparisons. To this end we have included a scatter chart below, that plots FSLR against its peers in the solar energy space based on their Adjusted Value-to-Assets ratio (V/A') and ROA'.
Looking across industries, markets, and time, there has been a very strong relationship between a company's ROA' relative to the corporate average (6%) ROA', and the multiple the market will pay above the value of the company's adjusted Asset' base, in terms of Adjusted Enterprise Value relative to Assets (V/A' or Value to Assets'). A company that generates a 6% ROA' will tend to trade at a 1.0x V/A', and company that generates an 18% ROA' will trade at a 3.0x V/A', etc.
Relative to its peers in the solar space, FSLR looks substantially undervalued with its 0.5x V/A' and 6% ROA'. While SunPower (NASDAQ:SPWR) trades at a similarly discounted 0.5x V/A', it generates a -5% ROA', justifying this steep discount. On the other hand, JA Solar (NASDAQ:JASO) trades at a 0.6x V/A' with a weaker 4% ROA' while Yingli Green Energy (NYSE:YGE) trades at a 1.4x V/A' despite its similarly weak 3% ROA'. Meanwhile Vivint Solar (NYSE:VSLR) trades at a 0.8x V/A' with its -23% ROA', and Canadian Solar (NASDAQ:CSIQ) trades at a 1.2x V/A' despite its -4% ROA'. This shows that not only is FSLR trading at a substantial discount to peers with somewhat similar profitability levels (JASO and YGE), it also trades at a deep discount to peers generating negative returns, indicating room for material multiple expansion and equity upside.
Credit Cash Flow Prime™ Chart
Typically trading at such steep discounts to asset values (as FLSR is) is reserved for firms with serious credit risk. However, Valens' credit analysis shows that the firm has robust cash flows relative to operating obligations, a sizeable liquidity position, a robust recovery rate, and limited material debt maturities, indicating credit risk is very limited.
Below, we've included our Credit Cash Flow Prime™ chart for FSLR. The chart provides a far more comprehensive view of credit fundamentals than traditional ratio-based analyses. It shows the cash flow generation and cash obligations related to the credit of the firm, adjusted for non-cash financial statement reporting distortions from GAAP. The blue line indicates the gross cash earnings (Valens' scrubbed cash flow number) expected to be generated based on consensus analyst estimates and Valens Research's own in-house research team. The blue dots above that line include the cash available at that time while the blue triangles indicate that same amount plus any existing, available lines of credit.
The colored, stacked bars show the cash obligations of the firm in each year forecast. The most difficult obligations to avoid are at the bottom of each stack, such as interest expense. The obligations with more flexibility to defer year to year, such as pension contributions and maintenance capital expenditures, are at the top of the stacked bars. All of the calculations are adjusted for non-cash distortions that are inherent in GAAP accounting, including the highly problematic and often misused statement of cash flows.
As we can see above, FSLR has robust cash flows relative to operating obligations. Moreover, once the firm pays down the $550m they have drawn on their credit revolver that they have stated a commitment to pay down in the next 12 months, cash flows alone should be more than sufficient to service all obligations, including their consistent immaterial term loans, in each year going forward. On top of this, the firm has a sizeable liquidity position and a robust recovery rate on unsecured debt, which should allow them to continue accessing credit markets for liquidity if needed. Considering the fact that credit risk is nearly non-existent, the fact that the firm is being valued like peers that do have material credit risk is unwarranted. As such, multiple expansion is likely justified, which would drive material equity upside.
Valuation Matrix - ROA' and Asset' Growth as Drivers of Valuation
When valuing a company, it is important to consider more than a singular target price, and instead the potential value of a firm at various levels of performance. The below matrix highlights potential prices for FSLR at various levels of profitability (in terms of ROA') and growth (Asset' growth). Prices that are in excess of 10% equity upside are highlighted in black, and prices representing an excess of 10% equity downside are highlighted in red.
To justify current prices, FSLR would have to see ROA' fall below cost-of-capital, to levels not seen since the firm became profitable in 2006, while growing at rates in line with recent years. That scenario, however, appears incredibly bearish considering management's confidence about growth opportunities and their ability to meet updated guidance. Should the firm succeed in sustaining ROA' at current 8% levels, as they have in recent years, while growing at rates in line with recent years, material equity upside would be justified.
Moreover, relative to its peers FSLR appears substantially undervalued, further indicating multiple expansion and further equity upside are warranted. Even after considering the impact of a Trump Presidency on the renewable energy industry, FSLR remains incredibly undervalued. Markets are already pricing in a near-bankruptcy situation for the firm, and, despite what some pundits may say, a Trump Presidency certainly does not mean the end is near for renewable energy. Therefore, considering the recent sell-off in solar stocks related to the election, valuations have only become more attractive, boosting long-term upside potential.
To find out more about First Solar, Inc. and how their performance and market expectations compare to peers, click here to access the open beta of the Valens Research database.
Our Chief Investment Strategist, Joel Litman, chairs the Valens Equities and Credit Research Committees, which are responsible for this article. Professor Litman is regarded around the world for his expertise in forensic accounting and "forensic fundamental" analysis, particularly in corporate performance and valuation.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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